Easing China

Logistics in China used to be something of a maze in which, for foreign companies, most avenues were blocked. But the explosion of manufacturing and production in recent years has sparked change, and now the industry is moving fast, and foreign companies are making significant inroads.

This is the boom that follows the boom, as goods seek faster, cheaper and more efficient routes through, into and out of China. The country's logistics market is forecast to enjoy a 33% compound annual growth rate in the three years 2005 to 2007. And it is a market that is opening rapidly: restrictions are being lifted as China fulfills its WTO pledges, foreign investment is being actively courted, and ambitious government plans have been drawn up to create a vast, modern infrastructure spanning the country over the next fifteen to twenty years. China's overall economy, having enjoyed a wild growth spurt in its adolescence, will mature into a highly efficient entity only when the quality and extent of China's infrastructure, and of the country's logistics industry, catch up with development.

Yet if China's logistics market has taken its first few tentative steps towards modernity, it has a long way still to go. Logistics costs in China comprise as much as 40% of total production costs, compared with less than 4% in developed countries. Logistics also account for 90% of the total production cycle duration.

But where some see the market's flaws and deficiencies, others see its opportunities. Logistics companies are trying to plug a wide supply-gap that many companies could only dream of finding, and their prospects look bright.

"Third party logistics (3PL) has developed fast, but enterprises capable of providing integrated service are few and far between. The levels of specialization and organization are low," wrote Susan Wei in market research group Asia Pulse's September 2005 report on China's logistics industry. "[There are] great prospects for development."

3PL is the industry acronym for providers of integrated logistics solutions. A 3PL offers not simply transportation services but also expertise in supply chain management and can run a company's entire logistics program on that company's behalf. Global examples include Excel, DSC, and Tibbett & Britten Group.

Outsourcing logistics
After all, why do something difficult yourself when you can pay someone else to do it faster and for less money? That is the question that companies, including SOEs, have been asking in China over the last five years. According to Morgan Stanley, third-party logistics companies currently handle just 16% of the finished goods in China.

Major global shipping firms like OOCL, SAGA, Maersk, Schenker and Panalpina can sometimes build local relationships (in a JV with, say, a Chinese trucking company) where needed or try to go it alone when they have the clout (buying their own fleet of trucks, for example). Many such companies are aiming to build national networks in China that provide not only transportation, but also warehousing, refrigeration options and monitoring systems. They hope to better navigate individual transportation sectors by diversifying their options. If they succeed, they could lower prices, and raise efficiencies across the board.

Help from above
"3PLs are going to grow enormously in the China market because in the old days international companies were not allowed to distribute in China by themselves, so they had to rely on their Chinese partner for distribution," said Kris Chang, Managing Director of OOCL Asia-Pacific. "I think that will be the major growth area for logistics in China."

Hong Kong-based OOCL formed a JV in 1995 with the Shanghai port authority and two years later with Qingdao port authority. Both were special license arrangements as foreign companies have not been allowed to form majority-stake JVs with Chinese logistics companies until very recently. "You are now allowed to have a wholly-owned domestic company in logistics – we have a 30-truck outfit in Shanghai, for example. You can buy local companies outright these days," Chang said.

The government is not only opening up its logistics market to foreign investors (see figure III) but also investing in infrastructure projects for the future – vast projects (see figure VI). In fact, the two trends are closely linked since one of the ways China is seeking to afford such projects is precisely by courting foreign investors and partners, notably integrated logistics providers.

Problems with the locals
But foreign integrated logistics companies have had trouble expanding their market share, partly due to a traditional reluctance on the part of private Chinese firms to consider outsourced logistics solutions, said Chang.

He added that local companies use external logistics companies less, because traditionally they operate with their own divisions in logistics, and start out with their own trucks. To save money they tended to build their own logistics JVs, but OOCL's Chang sees a change in attitudes. "From day one they need help, which is the reason they now want to go for outsourcing instead of setting up their own logistics team," said Chang. A key challenge to logistics in China is the country's vast scale.

"Because China is so big, the distribution is very localized," said Guy Laforgue, Regional Director Asia Pacific of SAGA, a French integrated logistics provider with a global reach and partner Offices in twelve Chinese cities. "That's the major difficulty [in China], because you have to have reliable partners all over the country. You can't run your logistics from only one platform in Shanghai."

Size also means distances between major cities are large and that loss rates can therefore be high, especially given the low technology levels and the habitual failure to fully enclose loads traveling by train or road. On the other hand, goods with a higher value-to-size ratio, from shoes to DVD players, are prone to theft and are even used sometimes as payoffs to gain priority-of-passage at railway logjams.

Local logistics firms can also gain preferential treatment from local officials, and tend to have the edge on outsiders in handling the requirements of local firms. "I guess a lot of Chinese companies have a hedge on the local market because they have our industry knowledge, proximity of customers and the cultural, local expertise which can make things easier for their clients," said Laforgue.

The growth in the supply of Chinese goods, as well as its effect on trade policies abroad, also makes life difficult for the logistics operators. Thomas Gronen, head of marketing and sales for the China operation of Panalpina, a Swiss logistics provider ranked as the 7th largest integrated logistics provider worldwide in 2003, said this was one of the biggest problems for his company on the mainland. "Capacity is a real issue and there's the inability to seriously forecast capital requirements, what with Western textile quotas and so on."

Different paths, different problems
Nor do the problems end there. Individual transport sectors each have their own particular struggles too. Take the railways: China has 17% of the world's railways but handles 23% of its freight, by volume. Rail in China is impractical for food or for time-sensitive items. Damage, a 10-ton minimum weight on orders, delays, bribes and theft are all problems for those using trains to transport goods.

The roads have other problems. China's trucks carry 10 billion tons of goods per year (see figure I) but only one fifth of them are fully containerized. Only three regions have extensive road networks, the Beijing-Tianjin area, the Yangtze River Delta around Shanghai, and coastal Guangdong. Accidents, flooding, poor driving, city entry limitations and overloading (often by 50%) mar a sector that is most companies' first choice for inland goods transportation. Currently, 250,000 trucks in China need a major refit annually, and the repair sector is hardly quick-response. China's most important domestic freight transport medium is water. Boats and barges navigate the eastern sea-board and the 122,000 kilometers of other inland waterways. Cargo losses, bureaucracy, slow-operating wharves, bottlenecks and limits on foreign stakes in Chinese companies provide the largest challenges for companies whose goods travel by water. Shipping in China faces seasonal traffic jams, slow loading and unloading, and a shortage of berths, although China has more than 1,200 ports.

On its Chinese journey, for practical or financial reasons, a product might need to use two or more of these means of transport, even though loss rates at China's transfer points tend to be high. Thus a company needs to understand the particular problems of each transport sector and, for certain products, there will be sectors that are no-go zones, such as using rail for perishables. Some, like Haagen Dazs, buy a fleet of tailor-made trucks, but this is impractical for most companies. Even for local Chinese suppliers, navigating the maze that is China's transportation system, with all its problems and pitfalls, can be a difficult and time-consuming task.

Looking beyond domestic logistics
It is tempting to ask whether foreign or Chinese integrated logistics providers will finally win the day but it is probably the wrong question. The companies that do best will be those with the best Chinese networks and service, right? That might suggest that Chinese companies have the brightest future, since their networks are far more entrenched. As SAGA's Laforgue pointed out, the largest logistics company in Japan, as in Korea, is a domestic company, despite the open market. Foreign companies still lack certain key relationships too: "We will continue to do some outsourcing in order to make use of the famous guanxi (relations) with Chinese customs," said Panalpina's Gronen. As for specialist services, argues OOCL's Chang, foreign companies are unlikely to acquire a significant market share. He cites, amongst others, DG (dangerous goods) cargoes, adding, "You can't transform foreign intelligence into a special patent of a Chinese operation either." Plus there's the problem of staff retention when you acquire a Chinese company. "They tend to set up elsewhere." Yet although local monopolies will continue to prosper in certain market niches, the playing field is now more level than ever before, and foreign providers already enjoy a significant market share.

A few of them have a trump card too. Being an integrated logistics provider alone may not be enough. The market now embraces those companies who serve the international market too – 4PLs to those in the industry. They have a good network of relations in several markets around the world. They have the technology for clients to track their shipments of goods not by an abstruse system that requires individual shipment codes but with a simple order code. They use technology to allow e-marketing and they deal with all the complications of pre-loading, custom house brokerage (often thorny in China), carrier relationships and warehousing. A Chinese retailer, for example, can trust his foreign 4PL to always know the details of his order's journey before it left port in the US. Although Chinese companies are now looking to create networks in developed countries too, that will be a harder task in markets that are already well established (for Chinese logistics providers, see table). But for all companies, foreign or domestic, it will be those who can adapt to this global perspective who will succeed in China.

One caveat should be attached, however. "We offer both 3PL and 4PL services – a pure 4PL is just acting as a kind of consultant, while we also organize and coordinate the movement of the cargo. Thus 4PL can be a value-added service but not a core business," says Panalpina's Gronen. Instead, 3PL remains at the heart of China's logistics future, although 4PL certainly adds a feather to your cap.

"We are 4-plus-3," says Chang. "We have inter-modal inland infrastructure but we also do a large amount of international work. We are seeking to be an overseas and domestic transportation company." His company is certainly not alone.

Logistics in China is on the verge of a revolution and, not for the first time, it is a revolution coming in from outside.

Express delivery
Foreign express delivery companies have been one of the success stories in China's logistics industry, some of them enjoying average year-on-year growth rates of 40% since 2001. The world's four leading companies in the sector – DHL, FedEx, UPS and TNT – all entered the Chinese market through JVs with Chinese companies. Today they account for 80% of the express delivery courier business in China, which had a total of 1,500 express delivery companies in 2003.

DHL announced in October that it would invest US$110 million to double its cargo-handling capacity at its Hong Kong hub six years ahead of target, making the facility its largest outside the US. The German-owned courier expects the project to be completed in 2007, facilitating the handling of 75,000 pieces of cargo per hour. The original facility only opened in 2004, and the capacity increases had initially been scheduled for 2009 and 2013.

Another company focusing on the Pearl River Delta is FedEx, which announced plans in July to shift its Asia-Pacific hub from Subic Bay in the Philippines to Guangzhou in southeast China. It also announced the opening of five new Guangdong province branches in September, bringing its China total to 18.

In September 2004, TNT opened a new Shanghai headquarters and in November opened the TNT University of China in conjunction with Shanghai's Jiaotong (Communications) University Antai School of Management in a bid to become the trainer of future Chinese employees working in the logistics, express and mail services. Meanwhile, UPS announced in July that it would build a new US$150 million international air delivery facility at Shanghai's Pudong airport in 2007.

Connecting China's west
Former premier Zhu Rongji once described many of China's new highways as "tofu constructions" – suggesting they were not built to last – but the country's west is now bridging its way into modernity.

There is certainly plenty of infrastructure building going on in western China. The 4.1-kilometer Erlangshan tunnel on the Chengdu-Tibet road is often compared to the Three Gorges Dam for its engineering complexity. The western city of Chengdu is developing four new logistics centers; the 1,100-kilometer Lhasa-Golmud railway is now complete; the Yichang-Wenzhou and Shanghai-Chengdu railways are finished.

In September, a road linking Kunming, capital of Yunnan province, to Laos was completed, and forms part of a highway that will some day extend from Yunnan to Thailand. The eastern section of the Kunming-Tibet road also opened this year, and a Tibet-Nepal highway is currently under construction.

Not all is well, however. Investors such as Asian Development Bank (ADB) cite serious problems with both corruption and inefficiency in China's west. When announcing its loans for western China road construction ADB complained "many local governments do not have the capacity to manage responsibilities delegated to them by the central government." Others complain that, although road and rail are gradually linking the west's big cities, this tends to only help the region's urban economies, thus exacerbating the urban-rural divide. The west is also resource-rich, and the railways may succeed in simply supplying the east with cheaper materials.

"The cost-benefit ratio of [building] rural roads is 4-5 times higher than investing in toll roads," said Joseph Eichenberger, Vice-President, Operations, Asian Development Bank (ADB), at an Asia Business summit in September. "There are over 55,000 villages with no road access at all."

Despite these problems, the government's plan to develop the west, a corner-stone of its 11th five-year plan, is bearing fruit. In the first quarter of 2005, Yunnan had the fastest growing provincial economy in China. The government is negotiating deals with foreign investors to ensure that the west receives significant investment in infrastructure. "We've agreed that 80% of our investment will be in central or western China," Eichenberger said.

A total of 25,000 kilometers of new railways are planned for western China, taking the total network to 100,000 kilometers. In the end, the west can never catch up without better education and healthcare, but roads and rails are at least a start.

China's top 10 logistics companies by sales

1. China Ocean Shipping Company (COSCO) Logistics
China's largest 3PL company, COSCO serves transportation companies by providing advanced logistics, agent services for freight forwarding and air transportation, warehousing, and container management. Headquartered in Beijing, COSCO has a nationwide logistics network system of more than 300 business outlets.

8. Kerry EAS Logistics
Kerry, which acquired EAS in 2005, was one of the earliest recognized agents of International Air Transportation Association (IATA) in China, with 100 branches and offices in China, and offers international air and sea freight forwarding, as well as international and domestic express services.

9. Tianjin Datian W. Group
This company handles international freight forwarding for import and export cargo as well as transit goods. It has a well-established network of 93 subsidiaries in 502 cities nationwide. Its JV, Federal Express-DTW, provides delivery services across China.

10. China National Material Storage & Transportation
CNMST is a member of state-run China Cheng Tong Group and one of China's largest comprehensive logistics comp-nies, providing storage, distribution, forwarding and value-added processing. It has 50-plus logistics centers in over 20 cities and runs its own railway connections.

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